PayPal’s (NASDAQ:PYPL) strong Q3 2017 results demonstrate that the company continues to sustain double-digit revenue and earnings growth. PayPal is achieving this though growth in the number of accounts, transactions, and payment volume. The stock is set to perform well in 2018 as earnings are expected to increase about 21% (consensus) as the company continues its growth. I think the stock will continue to perform well in 2018 based more on positive momentum with valuation being less of a factor.
Paypal is growing the business in every category that counts. In Q3, net new active customers increased 88%, transactions increased 26%, and payment volume rose 30%. This strong double-digit growth is driving the stock to outperform the S&P 500.
source: bigcharts.com
Paypal’s stock was tracking the S&P 500 since trading as an independent stock from mid-2015. However, the stock began outperforming the S&P 500 in May 2017. The breakout in the stock occurred as investors realized that the company could sustain double-digit revenue and earnings growth. The continuation of this rate of growth is expected to continue in 2018.
The Business Driving PayPal’s Growth
When I look ahead to 2018, I expect PayPal is to achieve its expected top and bottom line growth. The use of mobile payments is on the rise. Statista projects the global mobile payment market to grow at about 19% in 2018.
source: statista.com
PayPal has a convenient and secure solution for online payments that includes currency conversions from country to country. PayPal is an especially useful tool for online sellers as the service allows them to accept payments from their customers. It is also convenient for online buyers as they can safely make purchases with their PayPal accounts without worrying about sharing their bank or credit card information directly with numerous merchants.
PayPal is likely to continue to benefit from the growth of internet users. Internet user growth is projected to increase 5.3% in 2018. The percent of the world’s population that are online is expected to increase from 49% to 51.1% next year. PayPal is set to benefit greatly from this growth as the countries of the world become more connected through ecommerce.
Sites such as Alibaba (BABA) and AliExpress have many sellers in China that accept PayPal as payment. Buyers can make purchases from the United States and other countries using PayPal, which handles the payment transactions and currency conversions. I think it is the convenience, ease of use, and the sense of security for buyers and sellers that is allowing PayPal to grow at a strong pace. With internet users growing globally, PayPal will also continue to grow.
The addition of Venmo through the Braintree acquisition is accelerating PayPal’s growth. Venmo is popular with the largest living generation, the Millennials. Venmo customers now have access to pay with the App at over 2 million PayPal merchants in the United States. PayPal continues to work to get more large merchants to use Venmo. These efforts are paying off as Venmo’s payments volume increased 93% to 9.4 billion in Q3 2017.
So, 2018 looks bright for Venmo’s growth as PayPal continues to add large merchants for this service. Next year looks particularly bright for Venmo since it is expected to have a larger impact in 2018. PayPal is now charging some merchants that use Venmo. The service was initially offered for free to obtain large quantities of users. As PayPal gets more merchants to pay for using Venmo, the company is poised for more revenue growth going forward.
Why High Growth Momentum Will Trump PE Valuation
I think many investors miss the opportunity to buy a high growth momentum stock because they are turned off by what they perceive as an overvaluation. PayPal’s trailing PE of 58 and forward PE of 31.5 is above the
S&P 500’s (SPY) trailing and forward PE ratios of 22 and 19.6 respectively. That will cause some investors to dismiss PayPal as an investment. However, it is PayPal’s strong above average double-digit revenue and earnings growth that justifies this valuation.
For a high growth company like PayPal, the PEG ratio is a better valuation measure. If we look one year ahead, PayPal’s PEG of 1.5 (based on the forward PE of 31/expected EPS growth of 21) shows an attractive valuation for a high growth stock.
PayPal’s peers in the payment’s space, Visa (V) and MasterCard (MA), are trading at similar levels with one-year PEG ratios of 1.4 (23/16) and 1.5 (28/19) respectively. Visa and MasterCard also have above average PE ratios along with above average earnings growth. Visa and MasterCard’s stocks have outperformed the S&P 500 over multiple years even with their above average PE ratios. The stocks were driven to outperform by their above average earnings growth. Therefore, I expect PayPal’s stock to outperform the S&P 500 at least through 2018 as the stock will be driven by its above average earnings growth.
Outlook for PayPal’s Stock in 2018
With the large Equifax (EFX) security breach in the news recently and with others in the recent past, I think consumers will want to limit the amount of companies/merchants that have their bank or credit card information. The use of PayPal allows consumers to share their payment info with one company while they shop with multiple merchants.
I will point out one large risk for PayPal is the possibility that they will be hacked. If that happens, it could cause a significant slowdown in the growth of users and payments volume. That would also have a significant negative effect on the stock. My projections will assume that this doesn’t happen.
Paypal’s expected revenue growth of 20% and earnings growth of 21% for 2018 will drive the stock to outperform the S&P 500, which is expected to grow earnings at half of PayPal’s growth rate. I expect PayPal’s stock to increase about 20% next year, approximately in-line with revenue and earnings growth. This gives the stock a price target of $85.
David Zanoni
David focuses on growth & momentum stocks that are reasonably priced and likely to outperform the market over the long-term. He is a long term investor of quality stocks and uses options for strategy. David told investors to buy in March 2009 at the bottom of the financial crisis. The S&P 500 increased 367% and the Nasdaq increased 685% from 2009 through 2019. He wants to help make people money by investing in high-quality growth stocks.
Analyst’s Disclosure: I am/we are long V. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
The article is for informational purposes only (not a solicitation to buy or sell stocks). I am not a registered investment advisor. Investors should do their own research or consult a financial advisor to determine what investments are appropriate for their individual situation. This article expresses my opinions and I cannot guarantee that the information/results will be accurate.
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